Fortinet, Inc.

Hello and welcome to Fortinet's second quarter 2025 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, we will conduct a question and answer session. Please be advised that this call is being recorded. I would now like to hand the call over to Aaron Ovadia, Senior Director of Investor Relations. Please go ahead.

Thank you and good afternoon, everyone. I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the second quarter of 2025. Joining me on today's call are Ken Zee, Fortinet's founder, chairman, and CEO, Christiana Olgaert, our CFO, and John Whittle, our COO. Ken will begin our call today by providing a high-level perspective on our business. Christiana will then review our financial results for the second quarter of 2025. before providing guidance for the third quarter and updating the full year. You will then open the call for questions. During the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular the risk factors in our most recent Form 10-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements. Also, all references to financial metrics that we make on today's call are non-GAAP unless stated otherwise. Our GAAP results and GAAP to non-GAAP reconciliations are located in our earnings press release and in the presentation that accompany today's remarks, both of which are posted on our investor relations website. As a reminder, this is a live call that will be available for replay via webcast on our investor relations website. The prepared remarks will also be posted on the quarterly earnings section of our IR website following today's call. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I will now turn the call over to Ken.

Thank you, Erin, and thank you to everyone for joining our call. We are pleased with our strong second quarter performance, beating both our building and operation margin guidance. Building on this business momentum, we are reaching a four-year building outlook. In the second quarter, building grew by 15% and revenue grew by 14%, and we achieved a strong non-gap operation margin of 33%. Our strong top-line results were driven by continued momentum among large enterprise customers, with the total value of a deal over $1 million increased by more than 50%. This growth reflects the strength and value of our innovation, the recent global demand of our integrated solution, and the impact of our go-to-market investment. Additionally, our recent investments in the fast-growing market of unified SASE and AI-driven secure operations are continuing to deliver strong returns as buildings for both grow over 20% to a combined 35% of total buildings. Foodnet's strong momentum in SASE has been recognized by industry analysts, as we are recently named a leader in the 2025 Ghana Magic Quadrant for SASE platform, while also ranking number one in the secure branch network monetization case. We are the only vendor in the report that is also recognized in five different network security magic quadrants, which all run on a unified 40 OS. We continue to be the only vendor that has developed all core SASE capability in a single operation system, the 4DOS, including NetGen firewall, SD-WAN, ZTNA, Secure Web Gateway, CASB, and DLP. This native integrate of a NetGen firewall, SD-WAN, and SASE has become the new generation SASE firewall. making it easy for customers to adopt and upgrade while reducing complexity and operation costs, enhancing user experience, and ensure integrated hybrid secure access across both on-premise and cloud environment. Our success in unified SASE reflects the value customers place in our new generation SASE firewall, beginning with their investment in our industry-leading FortiGate firewall built on our FortiASIC. From there, most large enterprises expanded into our secure SD-WAN capability before advancing to our FortiSASE solution. As a result, 13% of large enterprise customers have purchased FortiSASE and increased over 60% year-over-year. Furthermore, we have invested around $2 billion to build and operate a global-owned infrastructure, spanning around 5 million square feet across data centers, NOC and SOCS customer supporting centers, executive briefing centers, and the research and development facility. This large-scale footprint gave us a competitive advantage in delivering fully SaaSy, fully cloud, and other cloud services. By owning and managing our infrastructure, we ensure better customer experience, better cost efficiency, strong data sovereignty, and high performance and scale. We also leverage our FortiSec technology to provide enhanced security and better management across our SaaS services. Today, we are expanding our Forti Cloud offering with three new services, the Forti Identity, Forti Drive, and Forti Connect. These services natively integrate into the FortiNet security fabric, providing centralized visibility, consistent policy enforcement, and real-time threat protection across users, devices, applications, data, and AI agents. In OT security, While we are achieving building growth of over 20%, we are recently named the overall leader in the Westland Advisor IT and OT Network Protection Platform Navigator 2025 report for the third time in a row, earning the highest ranking in both strategic direction and technical capability. We continue to invest in our AI, which we began developing more than 15 years ago, and hold over 500 issued pending AI patents, more than any other competitors. Our latest AI innovation, including fully AI protect for advanced threat detection, Food AI Assist for automating security tasks, and Food AI Secure AI for protecting AI infrastructure. As a result of our investment and recent innovations, our AI add-on solutions are the farthest growing part of our business. I would like to thank our employees, customers, partners, and suppliers worldwide for their continuous support and hard work. I will now turn the call over to Christiane.

Thank you, Ken. Thank you, Aaron. And good afternoon, everyone. As Ken mentioned, Fortinet's growth and momentum are strong. We beat our billings and operating margin guidance for the second quarter and raised our full-year billings outlook. Total billings grew by 15% to 1.78 billion, driven by 21% growth in Unified SASE and 31% growth in SecOps. Unified SASE and SECOPS now account for 24% and 11% of total billings respectively, up one point each. Our strong billings growth was driven by continued momentum in expanding into the large enterprise, as the number of deals greater than 1 million increased by 29%, while their total dollar value grew by 51%. Among our top five verticals, financial services, the vertical with arguably the most sophisticated and discerning security purchasers led the way with billings growth of over 30%. In addition, we continue to expand our customer base. Over 6,900 new organizations chose our unified single 4DOS platform to power their cybersecurity strategy. The robust growth in new customers is a clear testament to our strong position in the SMB market, driven by the continued commitment and loyalty of our channel partners. Total RPO grew by 12% to $6.64 billion, while current RPO grew by 15% to $3.45 billion. With regards to ARR, Unified SASE increased by 22% to 1.15 billion and SecOps increased by 35% to 463 million. Within Unified SASE, FortiSASE, our SSE solution, delivered strong results with ARR growth of over 100%, while the customer base expanded by 65%. Furthermore, adoption momentum has remained strong as 13% of our large enterprise customers have purchased FortiSASI, highlighting our continued expansion of FortiSASI in our customer base. As a reminder, the typical customer journey begins with the purchase of our FortiGate firewall. From there, customers often expand to our integrated secure SD-WAN solution before adopting our single vendor SASE offerings. reflecting the growing convergence of security and networking. Over 50% of our Fortisazi customers also leverage our SD-WAN solution, while 90% of our large enterprise Fortisazi customers began their journey with SD-WAN, reflecting the value of our integrated platform approach and the convergence of security and networking. Total revenue grew by 14% to 1.63 billion, led by EMEA with growth of 18%, while the Americas and APEC both grew 11%. Product revenue increased by 13% to 509 million, benefiting from upgrade buying and strong growth in operational technology. We saw growth in all geos as we continue to lead the cybersecurity industry and product revenue. Software license revenue grew at a high teens rate and accounted for a high teens percentage of total product revenue. Service revenue grew by 14% to 1.12 billion. Service billings grew by 17%, our highest growth rate in the past six quarters, reflecting many enterprise agreement renewals as our loyal customers continue to invest in our solutions and benefit from our strong track record of innovation. Now I'd like to highlight some seven figure deals that demonstrate how customers are adopting Fortisazi, consolidating networking and security, and expanding their overall footprint with Fortinet. First, an educational institution in APEC purchased solutions across all three of our pillars, including Fortisazi for 3,000 users. This customer chose Fortinet over the competition for our simplified, flexible, and consistent security enforcement, enabling secure access to both on-premises and cloud applications while delivering a seamless user experience. By leveraging FortiOS and Fortisazi, the school achieves superior performance, reduced total cost of ownership, and simplified operations through our integrated security platforms. Next, in an expansion and displacement deal, a leading retailer with 1,700 locations significantly increased their investment in Fortinet, purchasing solutions across all three pillars, including 40 APs, 40 switches, and 40 AIOps. Already a FortiGate customer with firewalls deployed at every location, the retailer selected 40 APs for all sites and 40 switches for 600 locations. with a remainder planned for early 2026. This customer chose Fortinet for our integrated 40 OS operating system, which enabled seamless convergence of networking and security. As part of the deployment, they adopted 40 AIOps to proactively manage their access points and switches, leveraging our AI-driven capabilities to improve operational efficiency. In another large deal, a top U.S. school district expanded its footprint with the purchase of 40 gates, 40 switches, and 40 APs as part of a 350-plus site refresh, displacing multiple vendors. Already utilizing solutions across all three of our pillars, including Fortisazi, the district continues to invest in Fortinet to drive deeper network segmentation, stronger security outcomes, and greater infrastructure resiliency. Due to their continued consolidation on Fortinet products, they are realizing significant operational benefits, including simplified guest access, accelerated deployments, and more efficient upgrade cycles, all managed through our unified FortiOS platform. Lastly, a technology company upgraded a portion of their high-end firewalls as a result of the upcoming 2026 end of support deadline and expanded their deployment with additional FortiGate appliances in the data center. They selected Fortinet for our FortiOS operating system, which enables streamlined operations while delivering a lower total cost of ownership. Turning to margins and cash flow. Total gross margin increased by 10 basis points to 81.6% and exceeded the high end of the guidance range by 60 basis points due to strong execution and cost control. Product gross margin of 67.8% increased by 180 basis points as inventory related charges normalized. Service gross margin of 87.8% was down by 80 basis points due to increased investments associated with the expansion of our hosted security solutions. Operating margin of 33.1% decreased by 200 basis points, while being 60 basis points above the high end of our guidance range. The year-over-year decline reflects increased investments in sales headcount, the absorption of costs from recent acquisitions, and foreign exchange headwinds stemming from a weaker U.S. dollar, as most of our operating expenses are denominated in foreign currencies. Free cash flow was 284 million, and adjusted free cash flow was 428 million, up 104 million. Cash generation in the first half of the year was very strong, with adjusted free cash flow reaching 1.27 billion, representing a margin of 40% year-to-date. Infrastructure investments were $168 million, up $145 million as we continue to build out our infrastructure footprint to support Fortisazi, FortiCloud and other services. We repurchased approximately 4.6 million shares of our common stock for an aggregate cost of $401 million in the second quarter. The remaining share buyback authorization as of today is approximately $1.6 billion. Before moving on to guidance, I'd like to provide an update on our firewall upgrade cycle and the broader macro environment. During our analyst day last November, we shared that approximately 650,000 firewall units will reach end of service by the end of 2026, followed by another cohort of 350,000 low-end units in 2017. While the 2027 cohort is less significant than the 2026 cohort in terms of product revenue due to its lower price point, firewall upgrade discussions offer valuable opportunities to engage with both our customers and channel partners, allowing us to showcase our ongoing innovation in 40OS. By upgrading to our new generation SASE firewalls, customers gain enhanced security capabilities and benefit from our unified platform approach. We estimate that we are approximately 40 to 50% of the way through the 2026 upgrade cycle at the end of the second quarter, based on the remaining active units and service contracts. And we expect continued upgrade activity for the remaining devices over the next six quarters. Our focus and open communication regarding the refresh allows allow us and our channel partners to have conversations with our customers around both. the upgrade in the customer's overall security strategy, benefiting us longer term. Despite ongoing uncertainty surrounding tariffs and the global economic outlook, we have not experienced a negative impact on our business. The cybersecurity market and the demand for our solutions remain strong and resilient. Now, moving on to guidance. As a reminder, our third quarter and full year outlooks, which are summarized on slide 17 and 18, are subject to the disclaimers regarding forward-looking information that Aaron provided at the beginning of the call. For the third quarter, we expect billings in the range of 1.76 billion to 1.84 billion U.S. dollars, which at the midpoint represents growth of 14%. Revenue in the range of 1.67 billion to 1.73 billion US dollars, which at the midpoint represents growth of 13%. Non-GAAP gross margins of 80% to 81%. Non-GAAP operating margin of 32.5% to 33.5%. Non-GAAP earnings per share of 62 to 64 cents, which assumes a share count between 772 and 776 million. Infrastructure investments of 110 to 130 million. A non-GAAP tax rate of 18%. Cash taxes of 60 to 90 million. As a result of our strong results in the first half of the year, we are pleased to have raised the midpoint of our full year billings guidance by 100 million. We maintained our total revenue guidance while adjusting the revenue mix by shifting 50 million from service to product revenue. Despite this shift towards product revenue for the full year, we maintained our gross margin range and slightly increased our operating margin guidance midpoint. We continue to remain on track to achieve the rule of 45 in 2025 for the sixth consecutive year. For the full year, we expect billings in the range of 7.325 billion to 7.475 billion US dollars, which at the midpoint represents growth of 13%. Revenue in the range of 6.675 billion to 6.825 billion US dollars, which at the midpoint represents growth of 30%. Service revenue in the range of 4.55 billion to 4.65 billion, which at the midpoint represents growth of 14%. Non-GAAP gross margin of 79% to 81%. Non-GAAP operating margin of 32% to 33.5%. Non-GAAP earnings per share of $2.47 to $2.53, which assumes a share count of between $773 and $777 million. Infrastructure investments of $380 to $430 million. A non-GAAP tax rate of 18%. and cash taxes of between 400 million to 450 million, which is 125 million lower than our prior expectation, primarily due to new tax law changes. I now hand the call back over to Aaron to begin the Q&A session.

Thank you, Christiana. As a reminder, during the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. Operator, please open the line for questions.

Thank you. If you would like to ask a question, please click on the raised hand button at the bottom of your screen. When it is your turn, you will hear your name called and receive a message on your screen notifying you that you may unmute yourself. We will allow a moment for the queue to form. Our first question will come from Shawl Eyal from TD Cohen. You may now unmute and ask your question.

All right. Thank you very much. Good afternoon team. Congrats on the improved outlook for the year. Um, General Christian. Um, one of the questions we are constantly receiving from investors is whether sales of 40 sassy potentially cannibalized the core appliance business. But but it would appear we're currently seeing tailwinds across both these segments. Can you help us maybe reconcile these views?

Yeah, I think probably we do see Cosmer expanding beyond the traditional firewall, but also traditional firewall is still the important control point for all this traffic, especially within the enterprise, within the data center. On the other side, some supporting whether work from home or traveling or some other branch office, that's also kind of a certain sassy, and especially certain like... Like OT, IoT use case, we see way beyond the traditional network security there. So we don't see SASE replacing the firewall. We just see it's keeping enhancing. That's what we call the SASE firewall. It's really the firewall itself need to keep adding new function. Like from 25 years ago when we started folding that, The new generation FAR will add like application control, like intrusion prevention, like antivirus in the traditional FAR VPN. Now the traditional FAR will also need additional like a SASE function together with some other edge device like for the AP for the switch and also endpoint device. and also the cloud deployment. So that's formed the whole protection infrastructure, which is ready to give much better security for the enterprise user.

And let me add to what Ken just said. In our win-loss analysis, we see very little reason codes for customers moving to the cloud and not continuing to buy. So... I think it's an expansion. It's not a replacement sale.

And to your point, we see both markets growing. And then if you look at the market share, they're very fragmented markets on the firewall side. And so we can grow both by the market growing on the firewall side and expanding our market share by taking business from other competitors.

Understood. Um and Christiane, thank you so much for the color about where we stand in the reefer cycle. Maybe a little bit of a long term view can already touching on the fiscal 27 cohort of products that will be refreshed. Other any specificities associated with those family of products as we think about the 20 27, which is coming to a renewal or a refresh.

Yeah, I think I've shared that in previous meetings potentially. The 2027 cohort is the low end of the low end.

So it's not – unit-wise, it's significant.

Product revenue-wise, it's not as significant. But that's why we included the –

The message in my remarks, it's significant because we can talk to a lot of customers about where the security is going, right? And so that's where it provides a lot of upsell potential for us.

Got it. Thank you so much.

Our next question comes from Brian Essex with JP Morgan. Please go ahead.

Great. Good afternoon. Thank you for taking the question. Maybe, Christiane, I was wondering if you could tell us, you know, what are some of the maybe unpack the services guidance a little bit. It's great to see the upside in the quarter, you know, particularly with regard to product billings and services strength this quarter. But how should we, I guess, what can we take away from the services guide and what's embedded in the guidance for the year given, you know, the strength that you're seeing this quarter?

So the services billings to revenue conversion takes a little bit longer, right? And that's what we're seeing based on the remaining waterfall.

We are pleased with our current RPO growth, but for the rest of the year, We decided to be prudent, take the midpoint down, but we believe that we are confident that the product revenue is going to be stronger for the rest of the year based on the pipeline.

Yeah, also probably last quarter is the first time in the last few years the product revenue growth is starting faster now. It's more like four years ago, like 2021. That time the product revenue grew very fast, and then that gave us a kind of benefit in the last few years. The service revenue is still maintained pretty healthy level, even the product revenue going down in the last one to two years. now we see the product revenue starting accelerating which will be the leading indicator for the future service revenue which we also feel since starting to turn around especially and both the product revenue and also the service revenue starting kind of instead of keeping dropping gradually uh probably will be starting taking up now do you have the the split for the guard for the care and is this the component of like if you if you have a refresh

Obviously, is it that customers aren't completely replacing their subscription revenue? In other words, they're just extending their subscription revenue with maybe less upside to that revenue line item? You know what I mean? So you have a new box with the same attached revenue.

Correct. So that's part of it. I think there's part of it that the...

Devices that they're using to replace, they may use a higher box, but they can consolidate one to two boxes, right? So it's different components that factor into the service revenue attached to the boxes. And this is where it's so critical for us to upsell not only SASE, but all our other revenue streams that benefit the customer.

That's super helpful, Paula. Thank you so much.

And based on the customer journeys, you can see the customer journeys work, right? The upsell is working. It's just not necessarily at the same point in time when they buy a firewall.

Got it. Understood.

Next question comes from Tal Liani with Bank of America. Please go ahead.

Ah, here we go. Now I unmuted myself, can you hear me? Yep, that's good. Okay, sorry. The SASE, the profile of SASE customers, what is it? Meaning, are these displacements of existing vendors? Let's say a customer has Zscaler or Palo Alto and you're displacing them. Are these, do they purchase at the end of a contract that they had before with someone else? Or are these completely green fields? They didn't have anything before. Now they're having, I'm just trying to understand where you have success with your SaaS. What is kind of the profile of the deployment, the types of deployments you're seeing? Thanks.

Both. From our current customer base, a lot of them, they do see the new operating system gave them the SASE capability, both the software and hardware. So that's where they started unable to SASE. You can see the slides for in the presentation. That's how we did in the SC1 a few years ago. Now the SAAS has become a fast-growing part of the business there, especially coming from the current installation base. But we also see quite a few worse successful cases replacing competitors. because we also, because we offer all these kind of integrated SASE solution. And some of our partners, especially service provider, also like this kind of a single OS solution. So starting code is SASE firewall, basically, just like how next gen firewall starting replacing the traditional firewall. This SASE firewall starting replacing Not just next-gen firewall, but also on the SASE. Because a lot of customers, they view SASE just like a few years ago, like a sandbox, like 20 years ago, intrusion prevention. Starting from separate solution, now they want to have an integrated solution with whatever the network security infrastructure technology they have. So once the integrated solution in place, the single solution starting kind of lost their edge and also starting kind of a huge disadvantage for actual management cost, for all the actual cost, basically. So that's why we see a lot of customers love the January, love all this SASE firewall solution and with all the integration solution together. So that's why we see both the current customer base and a lot of other customer front competitors quickly adopt this new solution and this is the fast-growing part of our business right now.

You said in the past that 95% of the customers are existing firewall customers. Is this still the case?

Pretty much, yeah. Yeah, over 90% come from the current customer base, but we do see some other customers which using our competitor's solution also changing to our solution now.

All right. If I can squeeze in one more, if not, we can move on, but I want to ask about the margins. You said in the past if you want to invest, what is the margin outlook and where is the balance between investments and margin upside?

Yeah, we like to play the long-term game. Same just like the SASE as we did in the firewall market, which we're the only one building ASIC chip. So for SASE, we also invest in the infrastructure, which has a much better cost advantage, also more secure compared to leverage some other third party infrastructure. So that's where we do believe if a long-term SASE kind of, if our own infrastructure can handle 70% of traffic, then 30% in certain locations still using third-party, that will be the best cost model. Even in the first few years, many need more investment. But long-term, both customer or partner and ourself will benefit. So that's where we do believe we have very healthy margin, and this model long-term gain will also benefit both ourselves and our customer, both short-term and long-term.

Thank you.

Our next question comes from Gabriella Borges with Goldman Sachs. Please go ahead.

Hi, good afternoon. Thank you. Ken and Christiane, I wanted to follow up on your prepared remarks that we are 40 to 50% through the 2026 refresh cohort. What I wanted to understand is how to think about your growth rate through cycles, because if I can pay your billings growth, what you're guiding to this year, It's about similar to what you guided to and what you achieved in 2023. But 2025 is a really big or larger than normal refresh cohort. So I want to better understand why are we not seeing more upside in the numbers this year from the refresh cohort? And the comment earlier on potentially consolidating down boxes, is it possible that perhaps customers have excess capacity in their networks from a 2021 COVID type elevated throughput environment? Would love to get your thoughts. Thank you.

Gabriela, good points. I think we need to look at it by 40-gate model.

And the large firewalls that are end of support, we have a really good reporting a handle on because we know where they are. These are always with enterprise customers, right? We have a good handle on the lower end of the firewalls where it's with enterprise customers and in retail or other scenarios, OT scenarios, where it's harder for us to predict And we can only track registration rates and similar is in the lower end. And there could be some excess capacity from prior years that has been replaced or that is replacing some of the EOS models. We are comfortable with our guidance. But yeah, the expectations by the street might have been a little bit higher, but we said we are outperforming the market and it was baked in, right? So we've been consistent in our messaging here.

Yeah, also the... the refresh or upgrade of the product go out the next year is the product usually been like 12 to 15 year after we introduce the product. It's not a product like four or five years ago when the supply chain issue happened. But if you compare to like 10, 12, 15 years ago, the business size probably like Current size is probably 5 ton, maybe even 10 ton larger. So that's where the... Yeah, the upgrade refresh we do see is very different than the supply chain issue a few years ago. It's a much older product. After we introduce a new product, the average selling may be like seven, eight years. And then after we stop selling, we're still supporting five additional years for the service after five additional years stop shipping. but we do support service, then the customer reach to the end of a service. So that's usually probably average, maybe like 12 to 15 years after the product be introduced. So that's the things we kind of try to help in customer to upgrade. And so like I said, even we have a large number of product, but that's usually the size of the business we have like 12, 15 years ago.

I would also say we have additional incremental TAM to address going forward with SASE and SecOps, where those are becoming meaningful parts of our business. So if you look at historical results, they were more focused on the firewall, but those are becoming real growth drivers for us.

Thank you for the call. Christiane, maybe as the follow-up, your commentary last quarter on hesitancy in the sales force and in some of the sales force conversations. I think today you said macro didn't have an impact on the business, so maybe just reconcile those two data points. Are you still seeing hesitancy? Is the hesitancy gone? Thank you.

I would say that We've seen that we are resilient despite macroeconomic uncertainty and the pipeline for the rest of the year and the sales confidence is good. So that's where we are confident to raise our billings guidance.

Thank you for the thoughts.

Our next question comes from Rob Owens with Piper Sandler. Please go ahead.

Great. Thank you for taking my question. Love for you to expand a little bit on the OT opportunity because I don't think I recall anything from your prepared remarks. Just in terms of what you're seeing there, both either increased competition or is this opportunity also playing into the refresh cycle? Thanks.

Yeah, that's my comment there. The OT growing over 20%, continue to be one of the fast-growing area for us, and also we're the only leader in the Westland, the OT, IoT security report. So that's where we see huge potential, and OT need to have a special product, even special software to handle. We invest in this area for more than 10 years. We don't see much other competitor. invest as we are so early, so broadly in OT security. So we do see, we do believe this is a strong growing area going forward.

And when you break down that over 20%, is that consistent internationally with domestically? Can you give me a view across the various theaters? I think it's pretty consistent.

Yeah, we are strong in OT across the board. EMEA has always been leading in OT for us. And that's where you also, I mean, it's aligned with a strong revenue growth that we see in EMEA as well, right? So you also, I think, asked whether it plays into the upgrade cycle. It does. We have a number of rugged devices that are part of the 2026 cohort benefiting from that. But we just see expansion and also the thought leadership that we've always had in OT and bringing this to the forefront of our customer as an important security area, I think has helped us a lot.

Thank you.

Our next question comes from Junaid Siddiqui from Truist. Please go ahead.

Thank you for taking my question. Just had a question. Can your SASE business, you know, continues to show a lot of momentum. Could you just talk about how your sovereign SASE solution is tracking and, you know, how that's different from some of, from what your competitors are doing in that space? And, you know, how important of a differentiator do you think that is in furthering your competitive moat in SASE?

Yeah, that's a great question. I like that a lot. That's also kind of my thinking in early days. I do believe with SASE long-term, the service provider carrier will play a more important role, just like how they did like 15, 20 years ago in the network security. But somehow they're moving kind of slow in the last few years. That's the reason we started launching on SASE almost two years ago. But we do work with a lot of carrier service providers. They do start and launch their own kind of SaaS service now, leverage both their infrastructure, their close relation with local customers there. So we do believe that will be the long-term trend because a lot of customers if not the most, they do concern who will be processed their data, where the data being secure processed. So that's where leverage the local service provider kind of solving SASE solution. That's all the service provider, especially telecom service provider, they love it a lot. Even they'll be slow on adopting all this SASE solution there, but I do see they are very strong supporting the sovereign SASE. That's one of the key advantage we have because we can have all the SASE function in the same OS, which they can deploy locally, whether in their own infrastructure or sometimes also in the customer premise there. So that's a huge advantage than some other SASE players. So we do see that momentum starting accelerating now. That's including the telecom area starting kind of also go back to grow probably above average now. So that's a strong area. I do believe probably in the next few years in the SASE market, the sovereign SASE probably can be taking almost half the market share compared to this global cloud-based SASE. So that's, I still believe, long-term, that's the long-term direction. Even short-term, there's some kind of changing back and forth, but long-term sovereign SASE, I do believe, will be the long-term solution.

Thank you.

Thank you.

Our next question comes from Patrick Colville with Scotiabank. Please go ahead.

Terrific. Thank you for taking my question. I guess Ken and Christina, I just want to circle back to the firewall upgrade comments. I mean, very helpful disclosure that we're 40 to 50% through the 2026 upgrade cycle. and that the 2027 end of life cycle is kind of lower throughput devices. I guess the question we're getting from investors in our inbox over the last half an hour is, what should we be excited about? Beyond this upgrade cycle, what is going to continue momentum when these tailwinds, which are clearly benefiting numbers now, and you guys are executing very well in a tough environment. But if we look beyond the 2026 upgrade and 2027 upgrade, what can continue this rocket ship momentum?

Yeah, I believe the excitement will be the new SASE firewall. So it's very different than the traditional next-gen firewall. So the customers do need a new function and also address a new infrastructure security need. So that's the huge opportunity, not just additional product but also additional servers on top of that, give them kind of a secure whole infrastructure. So that's why we're starting to train Salesforce, train the partner, and also customer for this new SASE firewall solution, which is where it gives them better security and also kind of a much better total cost of ownership also.

And let me add to that. I think when we talk about the up refresh cycle, we're only talking about the forced refresh due to end of support. But As Gabriella pointed out, there's the COVID cycle as well that's not end of support yet, but it's going to be five, six, seven years old in a year or two. So with security and with the additional functionalities that are part of the firewall and also the additional network, requirements that you have with running chat GPT, AI, you name it, we believe there are going to be enough tailwinds for us to continue to grow.

Yeah, I think to Ken's point, cloud services, that's growing really, really fast. And we view that as largely an incremental additional total addressable market for us. And like Ken said, it's what we have in SASE right now, and you can layer on additional cloud services over time, so that should be high growth. And we really like our model of the common operating system between firewall, SASE, SD-WAN, and we think that firewall market will continue to grow naturally as well, and we'll take market share there too. We've got all these other additional growth drivers in terms of SASE and SecOps, which are new TAM and really becoming meaningful to our business and are high growth.

Yeah, again, I feel we probably a little bit over. discuss about this refresh upgrade because this device has been there like 12 to 15 years ago. That time, our size is probably one fifth or one tenth of our current size. Even all this product being kind of refresh or upgrade within like one or two years still not much been its impact. So that's a few, the more important thing is really We leverage this opportunity to introduce customers with a new 40 OS, new hardware, upsell, cross-sell. So to measure the percentage of some old device being there like 12, 15 years ago, probably much less important than helping customers to upgrade to the new security infrastructure. And also the business impact for the old device also much smaller percentage than the total business we have today.

Okay, okay. Very, very helpful. And I guess, I mean, Ken, you've been a thought leader in security for many, many years. When we think about agentic AI security, I guess, how are you thinking about that domain and Fortinet's position as a vendor that can help in agentic AI security?

Yeah, I do believe, like keeping things for probably 10 years, whether the AI or the device security is getting more and more important than some of the people, human security, which people access. Right now, the device, even the agent probably already like 10x more than the people access all this information, Internet, all the data there. So that's where we invest in this area for more than 10 years and has a multiple angle to address the AI security, including agenda AI, including all this OT, IoT device security. So that's what we feel will be huge market potential, but also kind of a... need to address this instead of like a bolt-on, some of the old solution need to be integrated together. So example, whether you're judging AI, you want to check the identity or you want to check the access control, they need to be part of the infrastructure, just like a part of the firewall, part of endpoints. part of the edge device instead of a separate solution. So once this solution be integrated together, Cosmo will have a better management and also better secure infrastructure to address all this agentic AI or some other IT IoT device security there. So that's where the integrated solution address the whole infrastructure will be much better than like a separate solution which boils down some of the current solutions. So we do believe this long-term integrated solution will be the key to address this agent AI, the same as like an IoT solution security there.

Our next question comes from Saket Kalia with Barclays. Please go ahead.

Okay, great. Hey, guys, thanks for taking my questions here. Christiane, maybe for you, 40% to 50% through the upgrade cycle, can you just talk about sort of what that cadence is going to look like this year? I mean, I think that inter-quarter we were talking about sort of a 20% type of number. Maybe the real question is where do we end 25% in terms of the percentage of that cohort that we're through?

Good question. If you look at our updated guidance, you see that we believe there's strength in product for the rest of the year. Where we exactly end is hard to say because of course it's not only upgrade, refresh product that we are planning to sell. But I think we will get through those cycles faster than we expect.

Got it. Got it. That makes sense. Maybe the follow-up is, you know, I think you're hearing the question just about sort of what's the growth going to look like here after the upgrade cycle? And, of course, you know, it's Fortisassie, it's SecOps. I'm trying to think if we've talked about this before, but can we touch on sort of what percentage of the services revenue kind of comes from from those two businesses versus attached subscription, because just to the earlier point, that's really that mix shift that has to happen. So any color that you could sort of give on where we are in that kind of mix shift within services?

Mix shift between 40 care and security subscriptions?

Uh, yeah, well, maybe, maybe, maybe more specifically attached, attached sort of subscriptions and maintenance versus. Versus Fortis assy and sec ops. So, you know, maybe firewall versus non firewall in, in more lay terms, the non-attached subscriptions are growing faster for sure.

Got it. Yeah. Yeah. On the, uh, on the attached pod. The server is also starting to have a more high percentage because we offer more service. Whether the SD1, SASE, definitely there's more service, more function behind. So that's also starting to get a high percentage compared to the hardware. So that's both sides. There's some additional service, like we launched the 40 cloud service, the 40 identity, 40 drive, 40 connect. That's a new service attached, but there's also a touch service, which has a more higher ratio or percentage compared to the hardware side of it.

Very helpful. Thank you.

Thank you.

Our next question comes from Srinik Kathari with Baird. Please go ahead.

Hey, can you guys hear me? All right. So just a quick question on the go-to-market. You guys have been pushing towards platform adoption and multi-products. Can you talk a little bit about how the channel incentives are moving towards kind of achieving your internal targets? I mean, in terms of the rewarding models that are favoring platform cross-sell or pure volume. Can you just give us an update on what's been most effective in driving that? Where are the areas where you're still working on Yeah, I would really appreciate that.

Yeah, traditionally, we are a more channel-focused company. Now, in the last few years, we're more starting to invest in direct marketing, direct sales, especially all these big enterprises. So you can see whether the bigger deal and the big enterprise sales grow rather strong, like 40%, 50%. That's all come from all this direct touch approach and also integrate solutions, selling platform like a multiple product instead of a single product. That's also need to train the sales, need to train the partner how to sell this multiple solution, multiple product together into an integrated solution there, including whether the SaaS, the SD-WAN, including the secure op. So that's also kind of leading to the AI part of the story, which we believe is a fast-growing part of our business there. Even we only introduced for a few years, but that's AI kind of based, secure up, and also like a secure AI infrastructure to the AI, for the AI assist, for the AI protect. It's really customers see the benefit of this AI-driven operation, the SockMock operation center there. So that's what we do see is kind of an integrated solution with all this AI enabled kind of secure op. That's become a fast-growing part of business right now.

And to answer your question on the channel incentives, they are exactly aligned around multi-product.

So we make sure that the channel introduces new products and for that they get higher back-end rebates.

Our next question comes from Eric Heath with KeyBank. Please go ahead.

Hey, good afternoon.

Can you hear me? Yep, I'm good.

Great. Thank you. Just to come back to the comments on the refresh cycle one more time, and sorry for belaboring this point, but if I'm understanding this correctly, you've done well in excess of $100 million in refresh activity in the past two or three quarters, which would suggest product revenue, excluding this refresh benefit, has been flat to negative in the last couple of quarters. So can you just help me understand why the underlying firewall demand isn't stronger?

I would not say it would be negative. It's continued to refresh, but because it's such a small percentage of the overall business, that's the reason we gave additional building guidance for the rest of the year on top of what we are already overachieving Q1 and Q2. So that's just keeping, we believe, whether the market and also solutions is much better. We're not too much counting on the refresh. It's a very small percentage. We're just using the wheel to calculate whether internally or incentive the channel to helping customer to upgrade and especially for the new SASE firewall. So that's where we kind of, we do give a much more number measurement. Sometimes could be a little bit confusing, but I do believe it's the way we try to helping the customer partner to upgrade to the new SASE firewall instead of having too big a business impact because, like I said, the end of a service, that's the product been there 12, 15 years ago. It's a pretty small percentage of a total business.

Our last question comes from Andrew Nowinski with Wells Fargo. Please go ahead.

Okay, thank you for squeezing me in. I'm wondering, and I'm still a little bit unclear on why services revenue growth is decelerating so much, you know, looking back over the last, call it four quarters, and then also going forward. And I'm wondering if you could just provide any color around, you know, what's really driving that deceleration. And then, you know, related to that, Why is your unified SAS, if it has so much momentum right now, why would that be flat sequentially in Q2? Because it looked like it was about $1.15 billion in Q2 and the same thing that you had in your slide deck in Q1. So just wondering if you could comment on, you know, I know on a year-over-year basis as well, but sequentially, why would it be flat? Thank you.

To answer your second question for sequentially, it's flat because there are a number of products, some of them have not been growing or churning a little bit, while unified SASE, while SSE has been growing nicely and is offsetting that. So that's part of this.

On the service revenue growth, the I think that what you are seeing is that we had significant deferred revenues that were sold during the COVID period.

And they have come. So we've recognized service revenue over the last couple of years benefiting from that growth. And now the product revenue and the service revenue are aligning more with our billings growth. And so we need to grow faster, and we are planning to grow faster to drive both revenue streams up.

Yeah, the service revenue, if you're looking like three, four years ago, the product revenue grew like 30, 40, some quarter, maybe even close to 50%. That's drive the service revenue because service turn, your average may be like 30 months, 29, 30 months. So that needs to be recognized during that two and a half, three-year period. On the other side, I keep referring back to the presentation number four, slide number four, which is really The SAC part of SASE growing very, very strong because unified SASE also including SD-WAN. You can see SD-WAN, we already have a pretty good penetration rate in enterprise. That's where customer most starting adopt beyond SD-WAN starting quickly adopt SASE now. So that's where the growth still very strong. So we do believe, so we are the number one firewall, number one SD1. We do believe we will be the number one SASE within the next few years because we do believe we have a huge advantage on SASE as in a single OS and also can very easily for the current customer base. to upgrade to the SASE, which none other SASE player has as huge customer base. And also our own infrastructure give us cost advantage. So all these three advantage of a SASE none our competitor has, that's we do believe will be the number one SASE player in the next few years. Okay, thank you.

I'd say we focus on the value to the customer, and we've got 800,000 customers. And that path to value from firewall to SD-WAN to SASE with the integrated single operating system approach is really pretty straightforward. And so we see a huge opportunity both there and with new sales of SASE, and that'll be a real growth driver for us.

This concludes our Q&A session. I will now hand it back to Aaron Ovadia for closing remarks.

Thank you. I'd like to thank everyone for joining today's call. We will be attending investor conferences hosted by Deutsche Bank, Citi, and Goldman Sachs during the third quarter. The Fireside Chat webcast links will be posted on the events and presentation section of our investor relations website. If you have any follow-up questions, please feel free to contact me. Have a great rest of your day.